Stable Coin evolution and market trends

Key observations

PwC’s market analysis | October 2018

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2 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 3

Key observations in 5 9 Presently there are at least 75 projects Stablecoins should not be equated with the Stable Coin Evolution that could be considered “stable coin” asset they are backed by in terms of safety projects. With the deluge of projects and and stability. The legitimacy and long term the amount of capital they have raised, the viability of some stablecoins will be at the The stable coin evolution and trends discussed in this paper are the interpretation of information space could enter into its whim of investor expectations. Understanding gathered via market research and questionnaires sent to 50+ stable coin projects. They are own form of quantitative easing. This may be what these coins truly represent and their therefore interpretation of this data from the authors at the time this paper was drafted. driven by fiat or asset backed funds entering functionalities is a must for anyone who is the ecosystem that could find it’s way into looking to deploy capital into this market. George Samman investing into many of the cryptocurrency Co-Authors: John(3rd party Shipman expert) (PwC) George Samman projects trading on exchanges. [email protected] (3rd party expert) [email protected] https://www.linkedin.com/ in/georgesamman/ 10 6 Fiat-backed stablecoins can never be100% Executive Summary censorship resistant, permission-less and Exchanges are hedging themselves against trust-less. However they do have substantial the risk of only having one asset backed benefits versus fiat currencies due to their stable coin and adding new fiat-backed (USD ability to be programmable (both for money mainly) stablecoins onto their exchanges and compliance) and easily transferable. 1 3 at great pace. Projects to note in this regard are Okex and who appear Fiat-backed stablecoins need to establish An associated set of ancillary services to have added a number of stablecoins traditional banking relationships in order to will also need to evolve around the recently to hedge in this manner. hold the currency that the stablecoin is backed validation, certification and reconciliation 11 to. There are still several inhibitors for large of these reserves to digital assets. multinational banks to take on this role and Accountancies will need to evolve to Many of the projects are not simply offer this service, due to reputational, regulatory offer digital asset to physical asset audit looking to see their stable coins utilized uncertainty and therefore compliance risks. services for stablecoins (whether this is 7 for trading in the cryptocurrency Therefore, in many cases this role falls on the a currency, virtual or a physical asset ecosystem but to compete with fiat shoulders of regional banks, trust companies such as gold or iron ore or wheat). USD and Paxos Stablecoins, currencies on a global scale. or boutique financial institutions. With some of could be seen as the most regulated of these fiat-backed stablecoins being backed all the fiat-backed/asset backed tokens. to hundreds of millions of dollars this poses They are subject to the terms contained substantial solvency and credit risks. Uptake of 4 In the source code which include the right stable coin use is therefore in part reliant on of forfeiture or seizure and other reasons 12 traditional banking services. A whole new industry is beginning to form unrelated to the holding of the stablecoins. around stablecoins-ancillary plays like Corion We anticipate that the key innovations will X and Standard.one also known as Cement come from crypto-backed and algorithmic Dao (Cement DAO creates a decentralized backed/seigniorage based stablecoins. 2 ecosystem of stablecoin rating agents). The community of BUILD token holders vote to 8 As part of our research, many of the whitelist the “best” stablecoins, allowing survey respondents’ stable coin projects are them to be added to a diversified basket. One of the key focus areas for some 1:1 backed to digital assets (100% reserves) stablecoins achieving their stated as well as real life assets like USD or gold. stability goals will be to create As the markets take confidence in the baskets of uncorrelated assets. liquidity and safety of these new stable markets, the ability to move to fractional reserves will likely become a reality. (Fractional reserves - where only a % of the digital or physical asset backs the token)

4 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 5 1. General Observations

Price volatility is one of the most significant Only then will can it be considered a legitimate obstacles in the adoption of medium of exchange and store of value by for a number of reasons. Firstly, it keeps day-to-day users, merchants and savers. It the currency attractive mainly for traders is also difficult for merchants or even simple 5 7 and speculators, not ordinary day-to-day peer-to-peer transactors to conduct business if users interested in using it as a medium there is no consistent measure of value for the General Observations Launch & Marketing of exchange. Price fluctuations also cause cryptocurrency they would like to use. Volatility enormous currency risk, as cryptocurrencies is therefore a significant contributor to keeping can depreciate or appreciate dramatically cryptocurrencies as a niche digital asset favoured relative to fiat currencies, generating a loss by speculators. As opposed to its targeted for users who are holding cryptocurrencies. direction as a revolutionary technology that The loss can either be direct or indirect. allows a decentralised and secure flow of money.

a. Direct in that the cryptocurrencies Most Stable Coin projects we have observed 8 9 depreciate heavily against fiat. are currently built on top of the public network. Most appear willing to change if Indirect when cryptocurrencies appreciate, Economics Technology b. issues around scalability and sharding aren’t in that a merchant’s products are too fixed relatively soon. Some are building on expensive, making them uncompetitive. other (EOS3, Hashgraph4, Dash5, Or, employee salaries and supply chain trialled Ripple6 and Stellar7 NXT8, etc) and others costs increase, reducing their margins. have started by building their own blockchains (Bitbay and Algorand and Kowala and Topl). Thus, there needs to be stability within a range of currency values for both upside and The majority of the respondents are fiat backed in downside protection. This in turn will support in a 1:1 capacity followed by cryptocurrencies such 11 12 protecting incomes, savings, business margins as Ether or commodities such as gold. Others and to allow for more reasonable business are backed by a basket of different currencies Regulation Testing planning and forecasting when transacting (fiat and/or crypto) where they are using different or saving in this medium. Something akin metrics and standards to decide the weightings. 1 to a buy wall of a generic currency peg, Others such as Boreal, are backed from which prevents the price of the currency from revenues on a decentralised exchange IDEX. dropping and a sell wall2, which prevents a large upward spike, is necessary to maintain a stable value of a cryptocurrency such 14 that is comparable to fiat price stability. Appendix A: Questionnaire

1 A buy wall happens when the amount/size of buy orders for 4 Carbon. a particular coin are much higher than the number of sell 5 Xank. orders. Traders want to buy more than they want to sell. 6 SendGolD. 2 A sell wall is the opposite of a buy wall where there are many 7 more sell orders than buy orders. This is price negative. Stronghold, The White Company. 8 3 Havven & SendGold. RYOcoin. 6 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 7

Stablecoins are in the early development phase Revenue models17 used by respondents at this point in time and the design paradigms are (in no particular order): 2. Launch & Marketing still forming for what may be the future of money. a. Not for profit. Most of these coins are stable and being tokenized versus the USD.9 Based on the b. Revenue/dividends or investing part responses the USD should be the most tokenized of the asset in a low risk products like Bootstrapping18 is vital as all of these projects The following methods are being liquid asset in the cryptocurrency space over goverment bonds or money market funds. require liquidity in the coin. This can be done used to increase viability: the next 12-24 months. The other categories Network transaction fees which through incentivizing miners as in the case of c. Dual token models are being used so one are 1) other fiat currencies, 2) a basket of include workflow execution fees. Kowala. The ability to convert between deposits a. currencies, 3) commodities 4) cryptocurrencies in banks accounts and stablecoins are important can have capital appreciation of one of and 5) indexes like the consumer price d. Withdrawal fees. as is being able to trade on exchanges. Financial the tokens while the other token is pegged index (CPI) or a UN FAO Food Index.10 transparency is essential in order to prove out the to an underlying asset in the project. e. Vaulting fees in the case of Hellogold reserve, view transactions and other information for the physical gold (this will probably Dual token models are being used in some via smart contracts or be able to check on gold b. The models that are using baskets are trying become more common for other cases. One token is a dividend paying or revenue holdings or other types of assets. Redeemability to diversify currency risk by being stable types of commodities as well). share, or a price appreciation token that trades at any time and any price is also necessary. versus a basket of different currencies on listed exchanges and the other is the token and/or assets instead of just one. f. Coin creation fees. that is pegged to an underlying asset. Some Stablecoins rely on attracting users and getting related examples of this are Basis, Havven, g. Loan interest. lots of users in order to have long term viability. Confidence in the stability of the X8, Reserve, Staticoin and Sweetbridge. This is particularly true in the seigniorage token will come through: The purpose of the stablecoin projects (as model where platform growth is necessary to Being stable11 has different meanings for • Transparency in the code told by the teams) is to provide the next service the bonds. If growth in the amount of different people and projects. This includes • Stable banking relationships stage in digital money technology – and users falls, the prices will fall and more bonds their commonalities and differences in what • The ability for the technology to in some sense have opposing views: will need to be purchased making it more is meant to ensure stability. For a currency, work openly and publicly, difficult to pay the interest on the bond itself. in general stability is seen as its purchasing a. To create a stable, decentralised • The ability for pegs to hold in times power (which can be measured relative to an cryptocurrency—permission-less digital of stress, provable audits, underlying asset or a basket of goods, say) money—that can be secured, saved, and • Provable reserves and is desirable so that it can function as a unit sent instantaneously at almost no cost of account. The following show the range of and with no specific intermediaries. • Accurate asset pricing models. responses we understood from the research: b. To be compliant and transparent (particularly a. Stable means that the coin can buy fiat/asset backed stablecoins). roughly the same amount of goods and services from one day to the next.12 c. To build trust that the stablecoin can hold its value and in the team behind it. A stablecoin should be easily b. d. redeemable for the corresponding To replace as dollar backed models. 13 amount of assets it is pegged to. To create financial access for those e. who are currently restricted. c. Stable means easily predictable with respect to price outputs.14 f. To become a medium of exchange and a reserve currency or a store of value. d. Stable = grows at the rate of local inflation – it keeps value in real terms.15

e. Relative stability versus volatility of other currencies. Stability must be relative to something else.16

9 Specifically, USD denominated deposits 14 From Stableunit questionnaire in commercial bank accounts. 15 From Hellogold and Stably. 18  10 Bootstrapping is the process of starting with very little at minimal costs Pier. 16 From Saga and Reserve. 11 with the intended goal of building out a network to a large size. In one case, Augmint is using a DAO for stability. 17 Four of the projects label themselves as not for profit. 19  12 Formal verification is the act of proving or disproving the correctness of smart contracts with respect From Kowala questionnaire. to a certain formal specification or property. of autonomous agents (both individual or collective entities 13 From Carbon questionnaire. such as organisations or groups) with a view to assessing their effects on the system as a whole. 8 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 9 3. Economics 4. Technology

The performance of a stablecoin during Having an eventuality plan in case of a “black Since most projects are built on Ethereum and This is either a bank or information source, which worst-case-scenario market circumstances swan” event is critical. ‘Death spirals’ and positive use , formal verification is not an option. re-introduces centralisation into the equation. The is one of the most important components feedback loops can lead to a crisis in confidence If these projects move to other protocols in the first system, built on centralised banking trust, of a stable coin system. in the stablecoin that would be irrecoverable. future they will be able to use formal verification loses the original vision of using cryptocurrencies if the smart contracting language allows for it. as a free transfer of value without being subject Black swan events must be prepared for by Even an event with a 1% annual probability to control and limitations bound to government- managing the peg and providing stability during of occurrence can occur without knowing All the stablecoin projects in the survey approved identity and affiliation. In order to create times of extreme stress. Being decentralised the cause until after the fact. are using smart contracts with most fully stability the fiat collateralised tokens have to and having provable reserves mitigate automated and some semi-automated. some extent compromised on decentralisation. many risks but with all scenarios it is the Most have proprietary stabilisation mechanisms unforeseeable that is hardest to prepare for. in place or use 1:1 backing so even if the Formal Verification of smart contracts appear to Oracles are an additional trade-off. Many price went to .01 it would still be redeemable be an under-explored area due to limitations of projects require off-chain information to be The capital for maintaining the exchange according to the projects. Emergency shut-down Solidity code. If these limitations are overcome brought on-chain. Until a fully decentralised rate for the respondents to the procedures can be used in some cases as well. it will become a necessary inclusion, particularly oracle solution is built these projects will have questionnaire mainly comes from: Risk diversification is also a tool being deployed around verifying components needed for stability. to use a centralised oracle in its place. particularly by the companies using baskets. a. Market makers Trade-offs: Balancing stability with the Transaction throughput is limited by the Any pricing model must be robust enough benefits of decentralisation of cryptocurrency protocol and since most are building on b. Holders of the (unstable) coin: in to withstand a black swan event where all is one of the biggest dilemmas inherent Ethereum that limits TPS (transactions per second) the case of crypto the users over token holders sell at the same time. The in the structure of stablecoins. to ~15 per second. Most are hopeful for scaling collateralised the system reserve must have enough money in it pay solutions from Ethereum or looking to build on back all holders in this unlikely scenario. The trade-off occurs because pegging a multiple protocols or their creating their own in c. Currency auctions cryptocurrency to fiat currency involves case this is not solved. For those building on holding reserves of fiat in a central bank d. Regulated financial institutions other blockchains (eth , EOS, Stellar, and or vault or a commercial bank. ) thousands of TPS are being claimed. e. Banks Thus, there is no longer a trust minimised Use of oracles: There are several projects using system because users must trust that the coin oracles for management of external prices issuer has adequate fiat in the bank to back and other information. Approximately 60% the value of the coin. Also, cryptocurrencies are using oracles. Oracles are a centralised backed by fiat or other cryptocurrencies still component for any stablecoin project today but have price information that is not linked to the most will look and transition to decentralised underlying cryptocurrency. For example, priced options as they become available. in USD/Euro showing Godelian incompleteness. In both cases, the cryptocurrency is reliant on a central entity to ensure its value. 10 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 11

Stablecoin designs must balance between three Demand based models mint and burn tokens features: stability, decentralisation, and scalability. based on demand. Tokens only get created 5. Regulation when there is demand. Once supply goes down Stability is how stable an asset is with respect (ie a token is redeemed), the token is burned. to a defined base and has two components: the average volatility of the asset, and the worst- Most stablecoins are built on Ethereum so case volatility of the asset (how resistant the transactions are public. However Bitbay Stablecoins are of course subject to regulation. Many projects also believe clearer global stablecoin is to significant market downturns). keeps transactions private except between For example, AML/KYC is being implemented by coordination and guidance from regulatory bodies counterparties and Jabril anonymizes identity. many of these companies which increases the is severely lacking and needs to be addressed. Decentralisation is a measure of the degree of trust barriers to entry for those who want to hold and This response should also be harmonized in an entity to ensure the stability of the stablecoin. Many of the projects have centralised governance, use stablecoins. AML-KYC is being embraced as rather than fragmented within jurisdictions. with an entity issuing the coins and dealing with a key lynchpin to trust for many of the stablecoin Scalability is the number of transactions per second other centralised entities such as managing the projects particularly fiat/asset backed projects. Currently, there is no financial reporting but could have a secondary definition which refers banking relationships. The compliance element framework that allows for audit conformity of to the amount of tokens that can be minted. and vault selection also tend to be centralised. Regulation is still in the early days and most a stablecoin. This means that in today’s world companies are willing to embrace regulation with performing an “audit” isn’t strictly possible. There is an evolution of thinking and technology the view that they are getting/will get a better One must instead rely on a 3rd party to around the use of full, pseudo or zero anonymity response from regulators (fro stable coins) in attest to whether the 1:1 peg is accurate. for those people or organisations using tokens. comparison to other types of cryptocurrencies. Some central banks have considered tokens that replicate ‘cash in your pocket’ – that is, complete anonymity. Whilst public adoption would be significant, this is at odds with stopping cross- border use of these pegged tokens to avoid money laundering issues. True decentralists like Bitbay and Orcs only subscribe to this direction in our initial analysis and interpretation. 12 Stable Coin Evolution and Market Trends 6. Testing

The testing and modelling is mainly being Agent based modelling20 and Monte done by non-collateralised seigniorage Carlo simulations21 are for those projects coins, algorithmic-based and those that that are testing their models. are trying to use baskets for stability.

20 An agent-based model (ABM) is a class of computational models for simulating the actions and interactions of autonomous agents (both individual or collective entities such as organisations or groups) with a view to assessing their effects on the system as a whole. 21 Monte Carlo simulations are used to model the probability of different outcomes in a process that cannot easily be predicted due to the intervention of random variables. It is a technique used to understand the impact of risk and uncertainty in prediction and forecasting models.

Appendix 14 Stable Coin Evolution and Market Trends Stable Coin Evolution and Market Trends 15

v. Does your protocol require information e. Regulation Appendix A: Questionnaire outside the such as a feed of i. What are your perceptions of local and price data? If so, how does this oracle work? global regulation in supporting stable Who manages it, what are the incentives coin, asset backed token economies? for managing it, and what happens if the data they provide has a glitch? Note: you can decline to answer certain questions (like ii. What could be done to improve regulation in terms of speed, quality, marketing go to market) which may be trade secrets and we will vi. Which participants can see which value for your company? put in “declined to answer due to current trade secret”. transactions? What is the data and meta-data available, and to whom? f. Testing How does this impact privacy? a. General vi. Which monetary theory (theoretical) i. What kind of simulations have you done assumptions do you think are not true and i. Which blockchain/DLT are vii. Are you doing anything with formal and what have they helped you learn? how does your protocol account for that? you building on top of? verification? Smart contracts used? (simulating broad array of market conditions) vii. Does your stablecoin supply scale in ii. How does the stablecoin work? viii. What is the rebase period? (Length of ii. Mental models for simulations response to demand? If so, how? time between currency adjustments.) iii. What is the purpose of your iii. Econometric models viii. Who provides the capital to maintain coin?What does it aim to achieve ix. Can we make this automated? andwhich problems does it solve? exchange rate peg? How are they iv. Agent-based Modelling/ compensated? Why do you think they x. Do we use a , or network Computer simulations would continue to lock up capital, given iv. When we say something is stable whatdo rules of the blockchain operators? you think it means? And when itcomes other investment opportunities? v. Other (Please describe) to monetary policy specifically? ix. An eventuality plan in case of a “black swan” Broad classification of responding projects as interpreted by authors v. What is your revenue model? event. The 1% case will happen eventually.

b. Launch and marketing d. Tech Asset-Backed/ Crypto-Collateralised Fiat Collateralised i. What does the market need to beconfident i. Are any novel consensus mechanisms used, in the stability of your token? over and above the underlying blockchain? MakerDao Xank Jibrel Digix Global Collaterised Havven ////Etch ii. How are you bootstrapping to ii. What transaction throughput can the Rockz HelloGold Augmint Terramoney that level of confidence? blockchain currently handle and how does Vault Stronghold Bitshares Stable it plan to scale? Do its plans coincide with Soveren TrustToken Celo iii. What are your go-to-market strategies? your plans for your estimated demand? Nubits (TrueUSD) Onramp SendGold c. Economics iii. What trade-offs does your protocol make Globcoin Paxos i. What is your coin stable with respect to? and why did you make those tradeoffs? Gemini Dollar Meld (supply/demand, temporarily peg breaking) Circle USDC X8 ii. How much volatility can this peg (censorship resistance) (privacy trade- The White Saga withstand? Is that the same for upwards offs) (accuracy of present market data Co. Stably Decentralised and downwards pressure? How wide is and ease of manipulation of the data AAA Reserve Stasis the band of behaviour it can support? feed protocol uses (responsiveness of SweetBridge Stable market and ease of manipulation) iii. How easy is it to analyse the band of behaviour from which it can recover? iv. Are there any centralised components Capital Efficient of your system? Would any of these be Hybrid iv. How expensive is it to maintain easy for governments to shut down? Non-Collateralised the peg/stability mechanism? Phi Unum Basis ORCs Reserve v. How transparently can traders observe Kowala Carbon Ryocoin Alchemint the true market conditions? Topl Corion Aurora Fragments Bitbay Stableunit Contacts

John Shipman Henri Arslanian Financial markets partner ICO and Crypto Leader [email protected] [email protected]

Steve Davies Grainne McNamara Global Blockchain Leader (UK) US Blockchain Leader [email protected] [email protected]

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